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Understand Your Lender’s Approach – It’s Not About Your Equity

01/15/2016

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Like most farmers, the bulk of your net worth is likely in the equity of your ground. But you might have discovered a “land rich” net worth, even a sizeable one, doesn’t assure banks will approve a loan renewal.

Generally speaking, ag lenders are cash-flow lenders. Like you, they don’t like low commodity prices. While your net worth is important to them, they’re far more interested in a positive cash flow that allows loan payments to be made as agreed. That’s not easy today. Many of you are struggling to pencil out a breakeven, let alone a profit. And then there are loan payments. As a result, many farmers face troubled loan renewals. Don’t fall for the flawed argument that equity alone will get you through your renewal, but do tout your equity as additional support for your request.

To understand how lenders approach renewals, keep in mind they conduct a careful repayment analysis of each borrower. If you have multiple entities, this should be done on a “global” basis. Built into this analysis is an industry threshold of at least $1.15 in cash available to service debt (cash flow to make payments) for every $1 in debt service (loan payments). Put another way, if you have annual debt service of $100,000, you’ll need to be able to show $115,000 in cash available to service that debt. For some lenders, especially on new requests, the threshold is $1.25.

To gauge whether you have the required capacity, lenders look at your available repayment sources. It’s key to understand your farm’s profits—not your equity—represent the primary source of repayment for term loans. If profits are insufficient to adequately service debt at the $1.15 level or higher, your lender will look to secondary sources of repayment. Common secondary sources of repayment might include off-farm income, ancillary business income and investment income.

If these two sources fail to provide adequate means to service debt, the loan has become distressed, and lenders will look toward tertiary sources for repayment. This typically involves liquidating assets, which is where your net worth comes into play. There it is: Your net worth is neither the primary nor secondary source of repayment.

Your net worth is important because it provides options. It provides an outlet for addressing stagnant operating debt—the “stuff” that somehow ends up on every farmer’s operating line but has nothing to do with getting your crop in or out of the ground. Stagnant debt should be “termed out,” and you’ll need your net worth to collateralize this.

But perhaps the most important benefit of your net worth is its ability to generate cash. Every farm ought to be scouring its operation for unused or under-used assets. I’ve yet to come across a farm without an extra pickup or some other asset not being used efficiently. Get rid of this stuff now. The cash it generates is way more valuable. If things get really ugly, you can liquidate assets to protect the rest. While an unpleasant thought, it’s far better than the fate of those without a net worth.

Equity is important, but it’s not the driving force behind renewals. Be prepared to show your lender what your primary and secondary repayment sources look like. Quantify how much cash you could generate by liquidating excess assets if repayment became strained. Finally, have a game plan if all hell breaks loose and converting a portion of your net worth to cash becomes necessary.

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